Brussels last week unveiled a package of reforms to the Solvency II directive, including a short-term capital boost of up to €90bn ($105bn) for European insurers which it hopes will be used to increase investment in the region’s economy.

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However, (re)insurers say the moves do not go far enough, arguing that a more permanent reduction in capital is needed.

The European Commission (EC) said its proposals to change the Solvency II regime would allow EU insurers – which collectively have more than €10trn of assets – to ramp up their long-term investments and channel funds towards the European Green Deal.

In the short term an estimated €90bn of capital could be released, which the EU hopes will be funnelled by insurers as private investors to aid Europe’s recovery from Covid-19. This will fall to €30bn after all the rules are phased in.

Both European and UK insurers have long complained about Solvency II, a piece of EU legislation that took over a decade to create before it came into force in 2016. 

In particular, insurers argue that a part of the rules known as the risk margin requires them to hold too much capital when interest rates are low, as they are now, and that other parts make it too hard to invest in long-term assets such as infrastructure.

The EC’s review – which extends to 657 pages – proposes a reduction in the cost of capital for the risk margin from 6 percent to 5 percent and cutting the risk factor for equities from 39 percent to 22 percent for all insurers.

The reforms would also waive the mandatory application of Solvency II for 186 insurers, leaving 249 insurers within the scope of Solvency II.

In addition, the European Insurance and Occupational Pensions Authority (Eiopa) will be handed new powers to ensure data sharing between supervisory bodies and a common resolution regime across member states.

Carriers benefit but the system could weaken

Berenberg’s Michael Huttner noted that the reform package is broadly in line with the initial proposal published by Eiopa in December 2020. He said that while the final decision on what changes will be made rests with the European Parliament, the future framework is now “mostly set”.  

Huttner forecast that carriers with long-tail liabilities will be the chief beneficiaries from a reduction in the calculation of the risk margin. He pointed to guidance issued by Paris-headquartered Scor which estimated that a reduction would reduce the company’s risk margin by 22 percentage points, and thereby add 20 percentage points to its solvency ratio.

“The main negative is that supervisory authorities have been given a more formal framework for their powers to stop dividends, buybacks and bonuses”

Michael Huttner, Berenberg

But he noted that the review states that during periods of “exceptional sector-wide shocks” – such as the Covid-19 pandemic – supervisory authorities will be handed powers to restrict dividends, payments to subordinated creditors, buybacks and bonuses.

“The main negative is that supervisory authorities have been given a more formal framework for their powers to stop dividends, buybacks and bonuses,” he said.

Jefferies analyst Philip Kett noted a loosening of the restrictions of Solvency II is a “minor positive” for insurers, as it provides additional financial flexibility and may improve capital efficiency, but warned the moves could potentially weaken the system.

“We do believe that reviews such as this have the potential to weaken the stability of the system. Given that we believe that the risk profile of the European insurance industry is currently being managed better than at any previous time, we would be cautious of any reforms that may jeopardise this,” Kett explained.

“Having said that, we do recognise that we’re probably at the point of “peak prudence” and that there is a level of subjectivity in determining the appropriate level of conservatism,” the analyst continued.

Insurers call for “significant and permanent” capital reduction

It is not only analysts who have raised concerns. Following the publication of the EC’s proposals Olav Jones, deputy director general of Insurance Europe, said that only a “significant and permanent reduction of capital” would allow insurers to increase their contribution to the EU’s green agenda.

“A significant and permanent capital reduction would allow our industry to regain international competitiveness,” he said, adding that the capital reduction can be achieved while maintaining “very high levels” of protection for European policyholders.

Jones added that the steps that the EC has taken on proportionality “seem positive” but said concerns remain that the proposals for new reporting and group requirements include elements that would unnecessarily increase costs and complexity.

“A significant and permanent capital reduction would allow our industry to regain international competitiveness”

Olav Jones, Insurance Europe

“There are also significant proposals relating to recovery and resolution and we will be looking at these carefully to assess the degree to which these proposals are necessary and are aligned with internationally agreed standards.”

Similar concerns are being voiced by insurers across the Channel.

The UK has already decided to go its own way on Solvency II and in October last year, HM Treasury launched its own review of the rules as part of moves by policymakers to “tailor” the regime to support the “unique features” of the market following Britain’s exit from the EU.

The Association of British Insurers wants the rules to be diluted, and earlier this year urged ministers to reduce the capital buffer insurers are required to allow the sector to redeploy a total of £95bn for reinvestment.

At present both policymakers and regulators in the UK have rejected ideas of a “gratuitous deregulation agenda” and warned insurers the review is about “proportionate and appropriate” changes to reflect the UK’s position now that it has left the bloc.

Sam Woods, the head of the Bank of England’s Prudential Regulation Authority (PRA), said last week that he remains “cautiously optimistic” that the regulator will be able to come up with a “major reform package” to Solvency II.

But Woods said the regulator has not yet made up its mind on what form the overhaul will take, adding that any decision-making will be guided by feedback contained in the PRA’s qualitative questionnaire issued to both UK life and general insurers in August.

The EC has highlighted five material problems with Solvency II that should be addressed:

  1. “Solvency II still disincentivises long-term investment in equity and does not capture longer-term sustainability risks”
  2. “Solvency II does not appropriately reflect the low interest rate environment, and may unduly generate high volatility in solvency ratios”
  3. “Solvency II can prove to be overly complex for small and less risky insurers”
  4. “Failures of insurers operating across borders highlighted shortcomings in supervision and confirmed that policyholders are not consistently protected across the EU if their insurer fails”
  5. “The supervisory toolkit to prevent systemic risks may prove to be insufficient”